Australia’s superannuation system sets a global standard

There are not many areas where Australia can really be said to be leading the world but surprisingly superannuation is undoubtedly one of them.

A series of reports from the Thinking Ahead Institute has pointed to two really crucial differences between the way Australia runs retirement savings and the way other developed countries do so.

The first and perhaps most striking is that the majority of our funds – 88% – are in defined contribution funds rather than defined benefit funds.

That is a really unusual feature, with an average of just 58% in defined contribution funds in other developed countries.

Even that figure is a little over-egged.

If you leave the US out of the calculations, all of the other top seven members have the majority of their funds in defined benefit schemes, so we are by far the dominant user of defined contribution funds.

The fatal flaw of defined benefit funds

From a consumer perspective, defined benefit funds seem like a really great idea because they promise members a guaranteed payout on retirement – something some people would prefer compared to our more volatile system which can see balances rising and falling quite sharply in some years.

However, the initial design of superannuation to put the risk on to members rather than employers has had an interesting side effect, which leads directly to the other major difference seen here in Australia.

Fewer bonds, more shares

The old defined benefit funds that many other nations are depending on need to be run quite carefully and conservatively or otherwise the employer can get stuck with some very large risks down the track.

That means these funds invest a large portion of their assets in bonds which are arguably safer – although they have been quite volatile in recent years – but generally produce a lower return.

Australian super funds, by comparison, use a much higher percentage of shares and fewer bonds.

The Thinking Ahead Institute report shows that Australia has 51% of its superannuation assets in equities while the average among the top seven developed nation pension systems is just 42%.

The closest to Australia is the US, with 46% in shares.

The result of this Australian experiment with defined contribution funds with a higher tilt to shares is that our performance has literally been world-beating, which means higher balances for members compared to other countries.

Returns for Australia’s super system according to Thinking Ahead have been an average of 6.8% annually in local currency over a decade.

Over the same period the US funds averaged 5.8% while the giant fund in the Netherlands returned just 4.8%.

Rising contributions also driving growth

Another strength of the Australian system is that a growing percentage of wages have been directed into the super system – currently 12% – which along with better investment returns has grown the relative size of Australian superannuation faster than other countries.

Australian super assets as a percentage of the overall economy have climbed by an amazing 36.8% of GDP in the 10 years to 2023.

Back in 2013, Australian super assets were sitting at 108.3% of GDP but by the end of 2023 they were estimated to be the equivalent of 145% of GDP.

That left just Canada, the Netherlands and Switzerland with higher percentage figures, although the trend is obviously favouring Australia from here on.

What that means in practical terms is that Australia now owns more of the world’s assets than the world owns of ours – we have effectively exported our savings and invested them around the world because they have outgrown our own country.

That means there is a growing stream of income and capital growth coming from offshore.

That has also led to a situation where some of our super funds now have global scale, with six funds now in the top 100 international pension tables.

That includes really large funds such as AustralianSuper, Australian Retirement Trust and the Future Fund.